Join Cascade Partners Director, Arjun Murthy as he and Michael Romaya, Attorney with Varnum LLP discuss the state of financings in today’s economic climate and the impact supply chain issues and the ongoing pandemic.
Video Transcript
00:00:06:08 – 00:00:22:23
Announcer
Welcome to Cascade Conversations. Join the team at Cascade Partners and their network of trusted advisers as they work to demystify details, terminology and strategies in the world of acquisitions, divestitures and financings.
00:00:22:26 – 00:00:43:24
Arjun Murthy – Director, Cascade Partners
Thanks, Mike, for joining us. So we have Mike Romaya here, who leads the corporate finance practice at Varnum Law Firm. Thanks for joining. I’m Arjun Murthy, a director at Cascade Partners in the Investment Banking Group. So Mike, today we wanted to talk about some financings and considerations for middle market business owners and kind of your perspective on the legal front.
00:00:43:27 – 00:01:10:23
Arjun Murthy – Director, Cascade Partners
So hopefully we’ll answer some interesting questions that some people have asked us over the last couple of years or so. But, you know, there’s been a lot of interesting things happening in the world as of late via the pandemic or supply chain issues, but also just a great market. Have you seen any type of tightening or any type of restrictions given some of the global issues happening or if things have remained pretty robust from your perspective?
00:01:10:26 – 00:01:49:27
Michael Romaya – Attorney, Varnum LLP
Well, thank you for having me. And from what I’ve seen, things have remained robust. I mean, the markets remain strong. There’s a bunch of lenders out there in various different categories of lenders that are looking to deploy capital and really be a growth partner for companies doing acquisitions or to finance Recapitalizations or LBO. So despite the things that have gone on over the years with respect to COVID and now the war, the markets here, at least in the middle market, definitely have remained strong and sort of remain borrower friendly.
00:01:49:29 – 00:01:58:21
Arjun Murthy – Director, Cascade Partners
And, you know, and we’re thinking about some of these agreements that the borrowers are looking at, because I know you represent both lenders as well as borrower. Is that correct?
00:01:58:21 – 00:02:17:02
Michael Romaya – Attorney, Varnum LLP
Correct. Yeah. Our group, we represent lenders, a lot of regional banks, nontraditional lenders and a lot of borrowers, you know, across the various spectrums from ABL base facilities, cash flow based facilities, as well as real estate and construction financing.
00:02:17:05 – 00:02:35:20
Arjun Murthy – Director, Cascade Partners
So it gives you a pretty good perspective of kind of how both parties across the table are thinking here, kind of what these agreements really entail. So from a borrowers perspective, you know, what are some things that they can proactively do to prepare if they want to undertake a growth financing, acquisition, financing, etc., that can make things go a bit more smoother?
00:02:35:22 – 00:02:58:00
Michael Romaya – Attorney, Varnum LLP
Yeah. And one of the first thing that they should do is make sure, like their their house is in order to make sure they’re covering documents, other material, contract acts like leases actually accurately reflect the relationships that are that are currently in place, that that will help streamline the process. And you also want to do a lot of your financial modeling with your advisors.
00:02:58:03 – 00:03:28:01
Michael Romaya – Attorney, Varnum LLP
If you’re a financial buyer and you are, you expect to do a lot of other add on acquisitions. You really want to spend the time making sure you model out the right projections and as best you can. And then also make sure your credit agreements reflect that making sure your financial covenants have the right ramp up period, have the right add backs, because you really want to avoid defaulting on covenants out the gate because that can send the wrong message to the lending group.
00:03:28:04 – 00:03:35:04
Michael Romaya – Attorney, Varnum LLP
So some time more time spent on that in the front end as well worth it as a relationship goes out with your lenders.
00:03:35:07 – 00:03:51:05
Arjun Murthy – Director, Cascade Partners
So it sounds like that was a little bit of an indirect plug for having Cascade and Varnum. So a good team of advisors ahead of time. So ideally we’re thinking about it from the legal context. You know, what would be the ideal time frame to bring someone like you in from a borrowers perspective? Mm hmm. I would say.
00:03:51:05 – 00:04:11:18
Michael Romaya – Attorney, Varnum LLP
We want to start, you know, even before you start gathering your term sheets and going to market, if we can, you know, get in there maybe a few weeks or a month ahead of time to review your corporate documents again, your material contracts, and just spend some time getting an understanding of what you’re looking to get out of the financing as well as we can.
00:04:11:18 – 00:04:29:28
Michael Romaya – Attorney, Varnum LLP
You know, if there are already errors or things that need to be fixed in those documents, we can make the corrective changes. We don’t need too much too long of a time to get that done. But, you know, a few weeks out to a month is really advantageous because we start trying to address those concerns during the process.
00:04:30:00 – 00:04:39:00
Michael Romaya – Attorney, Varnum LLP
Frankly, it just becomes more expensive and, you know, can distract from the overall timeline of getting the deal closed.
00:04:39:03 – 00:05:09:09
Arjun Murthy – Director, Cascade Partners
Now, that makes sense. Oftentimes we see, you know, and we’re guilty of it, too. People are trying to bring us in at the last minute. And you’re kind of playing a little reactive basketball there. So we try to not do that as much. But I know you still are able to have success in those situations. Yeah, there’s a lot of different types of lenders out there right now in the universe, ranging from, you know, traditional large banks and institution and other types of private credit funds, business development funds, unitranche players, SPACs.
00:05:09:12 – 00:05:13:27
Arjun Murthy – Director, Cascade Partners
You know, what are you seeing in the middle market and how do structures vary by different types of lenders?
00:05:14:02 – 00:05:39:19
Michael Romaya – Attorney, Varnum LLP
Yeah. So I mean, you have your traditional bank lenders that are going to be more relationship driven. You know, they’re going to have tighter leverage constraints and maybe a little bit tighter a box to fit in. But you generally going to get if you don’t, you fit in that box, you’re going to get some more favorable terms. Then you’ll see from the nontraditional lenders, obviously, the nontraditional lenders are going to have a higher cost of capital.
00:05:39:22 – 00:06:01:26
Michael Romaya – Attorney, Varnum LLP
A lot of times there can be equity tickers or other things that are built into the deals to make sure that they get their certain returns that they’re expecting. And a lot of times, you know, those they work together depending on what what the snapshot is of the business. You’ll have a senior bank relationship and then you’ll have a relationship sort of in a subordinate position.
00:06:02:03 – 00:06:25:25
Michael Romaya – Attorney, Varnum LLP
And you really do want to make sure that your senior bank and your mezz lender have a good relationship. A lot of times they’ve worked on deals together in the past. So I think it’s very beneficial if you do have that structure to making sure your senior and mezz lenders, it’s been nice. Have they done deals together release are on the same page where the growth is going to be and you feel that you have a good working relationship.
00:06:25:27 – 00:06:46:23
Arjun Murthy – Director, Cascade Partners
And so if you do have kind of that bifurcated structure with maybe a traditional lender or some type of mass or unitranche player behind them, you know, what are some considerations from a documentation standpoint in a creditor agreement, I’m sure is something that comes to play. You know, where does someone like you kind of sit in terms of negotiating that, or is that really left to the two separate parties.
00:06:46:26 – 00:07:08:13
Michael Romaya – Attorney, Varnum LLP
Depending on what on what side that we’re on? I mean, obviously, the inner creditor and the majority of that negotiation is taken on between the two lenders with, you know, some input and comments from the borrower side. But that’s really the document that’s going to govern the relationship and how things are going to occur between the various the one else sort of versus the two lender.
00:07:08:16 – 00:07:31:14
Michael Romaya – Attorney, Varnum LLP
And then they’ll have, you know, in a syndicated deal on the one else side, you’re going to have the credit agreement and you also want to make sure the participants, if you do have a syndicated deal, are people that the borrower feels comfortable with, mainly the agent feels comfortable with. They’ve done deals with them because you want to have friendly lenders in the deal that all sort of see the company in the vision the same way.
00:07:31:20 – 00:08:01:11
Michael Romaya – Attorney, Varnum LLP
So a lot of times the agent bank is going to have various relationships and ideas to who to bring to the table for, for your bank group. And a lot of time based on what the industry is, they’ll try and find lenders that have experience in those markets. Like if you’re an agricultural company, you want to have some lenders that have some of that strong ag experience because you don’t want to have in the bank group is someone that gets uncomfortable or is in unfamiliar territory with the ups and downs that might happen in your industry.
00:08:01:13 – 00:08:19:12
Arjun Murthy – Director, Cascade Partners
Now, that makes sense. Having someone with experience and, you know, kind of understands it can kind and get through some of those intricacies of each business definitely would be the passive path of least resistance, you’d think, you know, but oftentimes it may not be such as Cascade, who’s a generalist, where, you know, sometimes you can add value regardless.
00:08:19:13 – 00:08:38:00
Arjun Murthy – Director, Cascade Partners
Correct. Going back to the diligence front, you know, quality of earnings is a big subject that we see on the sell side and by side from an M&A perspective. But on the financing side, are you seeing lenders typically require quality of earnings as part of diligence or are there certain times in which it’s not necessarily needed?
00:08:38:02 – 00:09:01:28
Michael Romaya – Attorney, Varnum LLP
Yeah, I mean, it’s it’s it’s very common, especially on the larger transactions. If you’re on a single bank, middle market type deal. No, you don’t. You don’t need them. But as you get into like the various bank group type structures or you have some component of subordinated financing, you do see them and they are common, you know, but you don’t see them commonly.
00:09:02:01 – 00:09:04:22
Michael Romaya – Attorney, Varnum LLP
One bank sort of middle market transaction.
00:09:04:24 – 00:09:32:15
Arjun Murthy – Director, Cascade Partners
Got it. Now, interesting then thinking through covenants, we’ve seen a lot of aggressive structures out there from all different types of lenders. And just given the rise and emergence of different types of lenders, things have become competitive. So have you seen any of that change as of late? You know, we’ve seen the Fed increase rates, have seen a couple more coming down the pipe here or have covenants pretty much stayed aggressive and, you know, thinking about the traditional two or three from a financial standpoint.
00:09:32:18 – 00:09:34:22
Arjun Murthy – Director, Cascade Partners
Yeah, how those changed. I mean, I’ve.
00:09:34:22 – 00:09:56:12
Michael Romaya – Attorney, Varnum LLP
Seen them sort of remain remain consistent with some sort of total leverage ratio, senior leverage ratio things charge coverage ratio or debt service. You know, I think people have sort of been expecting the rate increases over the years and now they’re coming to fruition. So as the various progressions happen, we’ll see the credit agreements start tightening up or what considerations those bring.
00:09:56:12 – 00:10:27:26
Michael Romaya – Attorney, Varnum LLP
But so far it’s been the same sort of traditional covenant reporting package that that you’ve seen. You know, as you get into sort of nontraditional bank financing, you have sort of board observer rights and you’ll have, you know, various set of, you know, potential warrants and other options that are that come into play into the documents. But from the senior position in general, you know, affirmative and negative covenants, they’ve remained consistent so far.
00:10:27:28 – 00:10:42:04
Arjun Murthy – Director, Cascade Partners
Yeah. I mean, he says that he regardless of bringing out a partner, there’s going to be some sort of increase reporting requirements probably that, you know, a lot of standalone businesses have been used to doing previously. But it can also be a good thing because it helps institutionalize that business as well.
00:10:42:08 – 00:10:43:13
Michael Romaya – Attorney, Varnum LLP
Yes, right.
00:10:43:15 – 00:10:50:23
Arjun Murthy – Director, Cascade Partners
Yeah. Thinking through the remainder of 2020 to any, you know, helpful predictions that people are crystal ball, they have.
00:10:50:25 – 00:11:19:19
Michael Romaya – Attorney, Varnum LLP
That I think things hopefully remain strong. I mean you know, so far deals are seems to be a lot of capital available throughout the market and we continue to see a lot of deal flow and a lot of activity. We continue to see the growth in the financial buyers. So I, I predict that’s going to continue. And I think though from the lending side, the banks are ready and as well as on traditional lenders to sort of support that growth.
00:11:19:19 – 00:11:40:12
Michael Romaya – Attorney, Varnum LLP
And there’s a there’s a big push to sort of partner up with the right management team and the right growth team to really see some of these returns that they’re looking for and really betting on the right management team that has a plan. And yeah, can a good prediction of where they can pick up value and know want to support that.
00:11:40:14 – 00:11:45:04
Arjun Murthy – Director, Cascade Partners
Well great. Appreciate the cellphone sites and this is a great conversation. Thank you.
00:11:45:06 – 00:11:46:27
Michael Romaya – Attorney, Varnum LLP
Now thank you for having me. Thank you, Arjun.